India's Narendra Modi Wins Big: Time to Finish Economic Reforms

23 Mar 2017

Doug Bandow

Despite imposing a disastrous “currency reform” that
impoverished poorer people and small businesses across his nation,
Indian Prime Minister Narendra Modi won big in five state elections
a week ago. His Bharatiya Janata Party’s sweep was
incomplete—the BJP lost one state and will rule only in
coalition in two others—but the BJP triumphed dramatically in
mega-state Uttar Pradesh.

There the BJP forged a broad coalition to overcome caste
politics and staged an effective grassroots campaign. Modi, rather
than local leaders, acted as the BJP’s public face. The
Observer Research Foundation’s Ashok Malik called it “a
stupendous achievement.” Even the Congress Party’s
Kapil Sibal acknowledged: “No doubt, it’s an astounding
victory for the BJP.”

The result strengthens the ruling party’s influence in the Rajya
Sabha, the nation’s upper house, which it still does not control,
and positions the BJP for reelection in national elections for the
more important lower house, or Lok Sabha, two years hence. Modi
parlayed a mix of business friendliness, reputation for competence,
and Hindu nationalism into a stunning national victory in 2014,
humiliating the long-dominant Congress Party.

Today, with the latter’s dynastic leadership in decline,
the BJP appears to be the natural governing party. No politician
has enjoyed such sway for years. Observed Sandeep Shastri of Jain
University: “Modi represents that national-level figure that
we’ve not seen since Indira Gandhi,” the Congress Party
prime minister assassinated more than three decades ago.

Modi also has made an international impact, raising his
country’s profile. He represents a people on their way to
greatness. Today India has the world’s fastest growing
economy and second largest population—on its way to becoming
the largest. English is commonly spoken and ethnic Indians are
productive traders around the world. Several years ago the Cato
Institute’s Swaminathan S. Anklesaria Aiyar noted that
India’s diaspora, at more than 30 million worldwide, is
another source of economic strength and international influence for
the homeland. The number of Indian students studying at American
universities is second only to those from China.

Growth has been driven by
government spending rather than private investment, and India’s per
capita GDP growth dropped early in the decade, a bad sign for
future economic progress.

Nevertheless, Indian voters were most interested in bettering
their lives domestically. Indians long languished in poverty as
their leaders followed a collectivist, dirigiste economic strategy.
New Delhi imposed confiscatory tax rates, employed a bureaucracy
rated the worst in Asia, nicknamed the “License Raj,”
and controlled the economy’s commanding heights. Indian
politicians pushed industrialization, but focusing on capital- and
skill-intensive industries, acting “against its comparative
advantage,” explained HDFC Bank, since “India’s
comparative advantage lay in an abundance of relatively low-skilled
workforce.” Indeed, New Delhi was not only a political friend
but also an economic mimic of the Soviet Union.

The consequences for the Indian people were catastrophic. Growth
lagged behind numerous other developing nations; until 1983 the
poverty rate was about 60 percent. There were brief attempts at
economic liberalization in 1966 and 1985, but both elite and
popular resistance remained strong. Real progress occurred in 1991,
freeing Indians to be more entrepreneurial. Eric D. Dixon and Tarun
Vats of the Atlas Network reported: “Within a decade, the
average income in India had doubled, and nearly 250 million
people—about a fifth of the population—have risen out
of poverty since then.”

However, progress remained incomplete, especially compared to
China, which became a global economic powerhouse. Explained Aiyar
in a recent Cato Institute study, “Although many old controls
have been abolished, many still continue, and a plethora of new
controls have been created.” Indians’ economic liberty
actually peaked in the mid-2000s.

The 2014 Economic Freedom of the World report, the most
recent ranking, rated India a disappointing 112 out of 159 nations,
down from 102 the previous year. (India did substantially better on
personal freedom, coming in at 77.) The Heritage Foundation’s
2017 Index of Economic Freedom rated India at 143 of 180 countries,
well behind China at 111. India’s rating dropped from the
year before, and New Delhi did particularly badly on investment
freedom, financial freedom, labor freedom, government integrity,
judicial effectiveness, and business freedom.

Although growth increased after liberalization, India failed to
overtake China as had been predicted. Since 2013 growth rates have
accelerated, though pulling 86 percent of India’s money out
of circulation late last year had a negative effect. The
International Monetary Fund originally forecast growth of 7.4
percent this year, but recently cut the estimate to 6.6
percent.

Other caution lights are blinking. Growth has been driven by
government spending rather than private investment, and
India’s per capita GDP growth dropped early in the decade, a
bad sign for future economic progress. Moreover, job growth remains
weak. It first slowed markedly in 2012 but has not recovered under
the current government, which according to HDFC Bank, indicates a
“growing disconnect between economic growth, education,
skilling and jobs.”

Nevertheless, India could pull ahead with better policies. TheMcKinsey Quarterly contended that deregulation would kick
growth rates up to ten percent. Inflation is lower than in other
“emerging markets” and the Economist Intelligence Unit
rates New Delhi’s “country risk” below that of
China. Growing wealth is spurring domestic demand: India’s
“consuming class” is expected to treble during the
coming decade. Democracy provides a political safety valve not
present in China.

Modi’s 2014 triumph reflected his pro-business record as
chief minister of the state of Gujarat and the widespread belief
that he would transform national economic policy as well. However,
despite his big win and large parliamentary majority, his
government has moved only slowly to free the economy. For instance,
the Times of India (New Delhi) complained about the slow
“implementation of projects” and that “the
government hasn’t pressed the pedal hard on reforms.”Business Standard (New Delhi) columnist Shankar Acharya
warned: “Economic reforms have clearly lost momentum and
there is a sense of drift in economic policy.”

In part this reflects opposition control of the Rajya Sabha,
whose membership changes only with state government control.
However, New Delhi’s failure to liberalize more also appears
to reflect the fact that Modi believes not so much in free markets
as in better managed markets. So, too, do other members of the BJP.
Milan Vaishnav of the Carnegie Endowment for International Peace
noted the party’s “nationalist, protectionist wing will
also demand a pound of flesh” after the UP victory. Moreover,
Sebastian Mallaby of the Council on Foreign Relations argued that
Modi “seems stuck in the mindset of a provincial executive:
he is more interested in projects than in policies; he is a
modernizer, not a reformer.”

The demonetization project is a dramatic example of a Modi
policy expanding government control over people’s economic
lives. Other counterproductive initiatives include agricultural
price controls and attacks on “hoarding.” Worse,
according to the Telegraph (Calcutta): “the Modi
government has started to drum up the virtues of creating large
state-owned assets in a throwback to a Nehruvian era of creating
state monopolies in strategic areas.” This is a prescription
for economic stasis.

Still, the Modi government has restrained spending, sped
environmental regulatory approvals, eliminated capital and
certification barriers for new businesses, streamlined distribution
of welfare benefits, improved sanitation, and attempted to move
poorer Indians into the financial system. New Delhi also has begun
to improve the electrical grid and transportation infrastructure.
Perhaps most important have been passage of a new bankruptcy code
and a uniform goods and services tax (GST) to replace a complex and
confusing hodge-podge of regional and national taxes (though the
new levy itself seems more complicated than necessary). In January
the government eased limits on foreign direct investment, including
in the aviation, defense, and pharmaceutical sectors.

These are important steps. However, much more remains to be
done. Eswar Prasad of Cornell argued that the government must
demonstrate its commitment “to deep-rooted reforms including
reducing labor regulations, unshackling businesses from red tape
and bureaucracy, reducing government control of banks and clearing
up their bad loans, developing capital markets, revamping the
government’s tax and expenditure systems and improving
infrastructure.”

For instance, New Delhi should end the web of government
controls over business hiring and firing. Companies with at least
100 employees generally require government permission to cut staff,
which is one reason nine out of ten Indians work in the informal
economy. Noted the OECD: “In labor markets, employment growth
has been concentrated in firms that operate in sectors not covered
by India’s highly restrictive labor laws.” In contrast,
in regulated areas employment has been falling. Moreover, contract
employees account for almost half of the workforce at large
industrial firms, compared to under nine percent in service
enterprises.

The American Enterprise Institute’s Derek Scissors
observed that such restrictions “essentially guarantee mass
underemployment and an India that, unlike its neighbors in East
Asia, cannot benefit from global demand for manufactured
goods.” Yet one unnamed BJP official told theTelegraph (Kolkata): “if it’s a conflict
between a corporate entity and its workers, we have to be on the
side of the workers.” Even though those workers would most
benefit from new and better positions in place of their current
jobs.

Modi also should dismantle the state economic sector which has
expanded dramatically over the last couple of decades. Losses from
public enterprises run billions of dollars annually. Among the
biggest problems are public-sector banks. Profits are down and
negative overall. These institutions hold 70 percent of the
nation’s financial assets: alas, more than a sixth of the
loans are “stressed,” many unable to even pay interest.
Problem loans total roughly $200 billion, reducing credit for
productive enterprises and increasing chances of a financial
crisis.

In fact, many companies fear the future. Sales growth and
capacity utilization are low compared to the past, and business
confidence is the lowest in two years. Reported theEconomist in early March:”If India is indeed the
world’s fastest-growing big economy, as its government once
again claimed last week, no one told its bankers and business
leaders. In a nation of 1.3 billion steadily growing at around
seven percent a year, the mood in corner offices ought to be
jubilant. Instead, firms are busy cutting back investment as if
mired in recession. Bank lending to industry, growth in which once
reached 30 percent a year, is shrinking for the first time in over
two decades.”

New Delhi should respond by accelerating reforms. A foreign
investor told Open Magazine last year; “The BJP
underestimated the extent of the problem” and concentrated on
“low-hanging fruits.” However, spurring manufacturing
and reviving banks required more than “a few quick
fixes.” India also needs a change in economic philosophy, as
public support for statism if not old-fashioned socialism endures.
Economist Mohan Guruswamy of the Center for Policy Alternatives
observed that “There is still a distrust of private capital
and foreign capital, and a consensus on state control of industries
that cuts across parties. People still want a lifetime of
employment, a lifetime of assured income.”

Finally, government must perform better when it acts. India
remains a poor nation, so government welfare is no surprise.
However, there are nearly 1000 national programs, supplemented by
various state initiatives. The result, said Aiyar, is “a
bewildering variety of freebies,” many to the well-off.
Complained the Economist: “the plethora of schemes
in place for Indians to claim subsidized food, fuel, gas,
electricity and so on are inefficient and corrupt.” Better to
consolidate the in-kind benefits into individual cash payments. The
latter would reduce inefficiency and corruption and return
decision-making to the poor.

Moreover, observed Aiyar in his Cato study: “With almost
no exceptions, the delivery of government services in India is
pathetic, from the police and judiciary to education and health.
Unsackable government staff members have no accountability to the
people they are supposed to serve, and so callousness, corruption,
and waste are common.” A mix of privatization and better
management are necessary.

Unfortunately, India’s economy may suffer from the ongoing
surge in Hindu nationalism. Modi got his start in the Rashtriya
Swayamsevak Sangh, or RSS, which promotes Hindu nationalism. While
in Gujarat he was blamed for mob violence that killed hundreds of
Muslims, though his responsibility was never proved. Religious
persecution and intolerance, long present in India, have worsened
with his 2014 victory. Warned the U.S. Commission on International
Religious Freedom in a report issued last month: “threats,
hate crimes, social boycotts, desecration of places of worship,
assaults, and forced conversions led by radical Hindu nationalist
movements have escalated dramatically under the BJP-led
government.”

Most violence occurs at the state level, beyond the prime
minister’s direct reach. However, the BJP has pandered to
Hindu nationalists. For instance, in last week’s election
Modi accused the ruling local party of favoring Muslims. After the
BJP victory he appointed as UP’s chief minister a
parliamentarian who doubles as Hindu priest and violent
provocateur. Indeed, Yogi Adityanath was briefly jailed for his
incendiary rhetoric against Muslims. He also has pushed for
building a Hindu temple on the site of a mosque destroyed years ago
by a mob, which triggered deadly sectarian violence.

To the extent these violent currents ripple outward, foreign
investment could suffer. Warned Manu Bhagavan of Hunter College,
such “regressive identity politics … are more about the
last century than the next.”

India is gaining economically. But continuing liberal reform is
necessary to sustain strong economic growth. Modi is India’s
most popular politician and dominates the national political
landscape. So far he has only cautiously pushed economic reforms,
but voters have credited him with making an effort, even forgiving
the bungled currency reform since it was targeted at the well-off.
He has two years left before the next national contest.

After last week’s election Jain University political
scientist Sandeep Shastri predicted that Modi “will likely
try for some measures in the coming months that will capture the
imagination of voters that will help him win in 2019.” But
that won’t necessarily be economic liberalization. After
being accused of running a “suit-boot” administration
too friendly with corporate elites, he turned more populist.
Novelist Pankaj Mishra argued that Modi relied onressentiment by “presenting himself as a relentless
scourge of elites and sentinel of the upwardly mobile.” The
Brookings Institute’s Tanvi Madan predicted that Modi will
move forward on the anti-corruption front, which “is
something that resonates with people.”

Does Modi want free the economy? Madan contended that
“It’s been established that he is not a free-market
guy.” Indeed, Modi looks ever less like Ronald Reagan, to
whom the prime minister once was compared, and more like Donald
Trump, argued Ruchir Sharma of Morgan Stanley Investment
Management. Polls indicate that Indians increasingly want a strong
leader, and Modi is “concentrating power in his own hands,
thus shifting the driver of economic growth from the private sector
to the state.” The ironic result may be a better managed but
not much freer economy.

India has come far. Extreme poverty still afflicts millions of
people across this complex and diverse nation, however. Much more
economic work remains to be done. If Narendra Modi desires to be a
truly transformational leader, he will press market reforms to
fully release the extraordinary economic talents of the Indian
people.

Doug Bandow is
a senior fellow at the Cato Institute and a former special
assistant to President Ronald Reagan.

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